IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCHES C (SPECIAL BENCH), MUMBAI.

Transcription

1 IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCHES C (SPECIAL BENCH), MUMBAI. Before S/Shri D.Manmohan, Vice President, S.V.Mehrotra, Accountant Member & D.K.Agarwal, Judicial Member I.T.A No.4404 & 1883/Mum/2004 Assessment year: & The DCIT (IT)-1(1), v. M/s. Bank of Bahrain & Kuwait, Room No.117, Scindia House, N.M.Road, BSC, Jolly Maker Chamber-III, Ballard Pier, Mumbai , Nariman point, Mumbai-21. PA No.AAACB 2140 F (Appellant) (Respondent) Appellant by: Shri Ajit Kumar Sinha (CIT-DR) Respondent by : Shri F.V.Irani Per S.V.Mehrotra(AM) O R D E R Act, The present Special Bench has been constituted u/s.255 (3) of the Income tax 2. The constitution of Special Bench resulted as under: The assessee is a non-resident company carrying on banking business in India. It enters into forward contracts with its clients to buy or sell foreign exchange at an agreed price on a future date. On the date of maturity, the contract is executed which may result in the profits or losses to the assessee. There is no dispute between the parties in respect of losses arising on execution of the contracts within the same year. However, in some cases, the date of maturity of the contract falls beyond the end of the accounting period. In such cases, the assessee evaluates the unmatured forward contracts on the last day of the accounting period on the basis of rate of foreign exchange prevailing on that date and books the loss or profit, accordingly. This methodology was adopted keeping in view the guidelines laid down by the Reserve Bank of India as per rates notified by Foreign Exchange Dealers Association of India (FEDAI). The

2 revenue s stand is that in view of the decision of the Hon ble Madras High court in the case of Indian Overseas Bank, 183 ITR 200(Mad), this method of accounting is not correct because the loss is incurred on the date of maturity of the contract and there cannot be any loss prior to such date. The assessee s stand is based on the decision of the Mumbai Tribunal in the case of Deutsche Bank A.G., 86 ITD 431(Mum) and FEDAI guidelines. In the reference order, it is pointed out that the decision in the case of Deutsche Bank A.G. (supra) proceeded on the basis that forward contract constitutes stock-in-trade, and, therefore, same could be valued at the end of the year, which may result into loss. It is further pointed out that in Deutsche Bank (supra) the decision of the Hon ble Madras High court was distinguished on the ground that the Court was concerned with the issue as to whether notional or anticipated loss could be allowed as deduction or not, while the Tribunal was concerned with the valuation of stock-intrade. The Bench referred the matter, since the assessee, as a banker, only enters into contract to sell/buy the foreign currency at a future date but does not buy or sell such contracts from or in the market. It is observed that the assessee is not holding these contracts as stock-in-trade and, therefore, the decision in the case of Deutsche Bank A.G.(supra) was not applicable. Accordingly, the Bench framed the following question for reference:- Whether on facts and circumstances of the case, can it be said that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the assessee on account of evaluation of the contract on the last date of the accounting period i.e. before the date of maturity of the forward contract. The Hon ble President, after considering the reference petition, referred the entire appeal for disposal. We, accordingly, proceed to decide the appeal on merits. 3. Facts are similar in both the assessment years; therefore, we discuss the facts as obtaining in the assessment year At this juncture, we may also point out that ld CIT (A) has followed the order for A.Y and, therefore, while considering the facts for A.Y , the ld CIT (A) s order for A.Y is to be referred. Brief facts of the case are that the assessee is a non resident banking company. It filed its return of income showing total loss of Rs.6,29,90,894/-. Thereafter, the assessee

3 filed revised return at Rs. Nil. The book profit u/s.115a was worked out at a loss of Rs.31,69,009/-, on the basis of original return of income. The Assessing Officer determined the total income at Rs.6,86,37,276/-, inter alia, making the following a d d i t i o n s : i) Interest accrued on investments : Rs.2,58,79,931/- ii) Broken period interest on securities lying in stock-in-trade. : Rs. 8,95,011/- iii) Loss on forward exchange transaction: Rs. 12,42,648/- iv) Deferred guarantee commission : Rs. 1,45,27,210/- (Rs.1,70,46,547 Rs.25,19,337/-) v) Interest attributable to investments in Shares : Rs. 1,01,34,587/- 4. For the assessment year also, the Assessing Officer determined the total income at Rs.2,77,54,853/-, inter alia, making similar additions as in the assessment year ld CIT (A) while partly allowing the assessee s appeals, has deleted the aforementioned disallowances made by the AO for both the assessment years. Being aggrieved with the decision of ld CIT (A), the department is in appeal before the Tribunal for both the assessment years. 6. Ground No.1 similar to both the assessment year is as under:- On the facts and circumstances of the case and in law, the ld CIT (A) has erred in holding that, income arising from securities and on debenture to the assessee is liable to be taxed on due basis and not on the basis of day to day. 7. Facts apropos this issue are that in the books of account, the assessee had recognized income from interest on securities on day to day accrual basis. However, in the return filed, the assessee had claimed that interest, which had not become due for payment during the previous year, should not be included as income. The AO did not agree with assessee s contention. After considering the various figures, he concluded that the assessee had not offered for tax Rs.67,20,565/- being interest accrued but not due. He noted that in earlier years also, the assesse was following same system of

4 accounting but it was not accepted. The AO further observed that the income accrues as and when the assessee acquires a right to receive such income or the right becomes vested in it. In this regard, the AO pointed out that in the case of Government securities although the interest becomes due for payment only at six monthly intervals, such interest certainly accrues from day to day, which is evident from the fact that when assessee purchases certain securities, it pays not only cost of securities, but also the interest which had accrued on day to day basis from the last date of payment of interest to the date of purchase. Similarly, he pointed out that when the assessee sells the securities, it received not only sale value but also the broken period interest, which had accrued on the securities till the date of sale. Thus, he pointed out that interest accrued day to day and the quantum of interest accruing is also known to the assessee. He relied on the decision of the Hon ble Supreme Court in the case of E.D.Sasoon & Co., 26 ITR 27 and Shri Govardan Ltd., 69 ITR 675 (SC). He further pointed out that the Hon ble Supreme Court admitted the SLP filed by the department against the decision of the Hon ble Karnataka High Court in the case of Canara Bank. He, accordingly, held that since the assessee was following mercantile system of accounting, the profit or loss at the end of the accounting year will be based not on the difference between what was actually received or paid but on the difference between the right to receive and the liability to pay. 8. Before ld CIT (A), it was, inter alia, contended that with the abolition of sections 18, 19 and 20 of the I.T.Act w.e.f , no provision is made in the Act to define separately the scope of interest on securities which could be taxable. Consequently, the interest on securities assessable would be the amount which could be charged under the charging provisions of section 5, which, apart from charging income on receipt basis, also provides for charging of income when it accrues or is deemed to accrue to the assessee. Section 145 of the Act provides that the income from business should be computed in accordance with the method of accounting regularly employed by the assessee. Such computation has to be within the ambit of section 5 and cannot override the provisions of the said main charging section. The interest on securities accrues only on fixed days, generally on a six monthly basis twice a year and does not accrue from day to day. Therefore, the owner of securities who is registered on the due dates is

5 entitled to receive the entire six monthly interest, irrespective of the fact whether he held the said securities for the entire earlier six months period or not. The previous holder of the securities who has sold the securities has no right to receive from the disbursing authority any interest from the last due date upto the date of sale. Reliance was placed on the decision of the Hon ble Karnataka High Court in the case of Canara Bank, 195 ITR Ld CIT (A) referred to the decision of the Hon ble Karnataka High court in the case of Canara Bank, (Supra) wherein, it was held that the interest on Government Securities does not accrue before the stipulated date of payment and as such only such interest would be taxable in the assessment year under consideration which has fallen due for payment during the previous year. The SLP filed by the department against the decision of the Hon ble Karnataka High Court in the case of Canara Bank (supra) has been dismissed by the Hon ble Supreme Court. He also referred to the decision of the ITAT Jaipur Bench in the case of State Bank of Bikaner and Jaipur, 74 ITD 203, wherein, it was held that even if the bank had accounted for interest on day to day basis in its books, the provisions of section 5 of the I.T.Act could not be ignored and the method of accounting followed by the bank could not override the provisions of section 5. He, accordingly, allowed the assessee s appeal. The department is in appeal before us. 10. Ld CIT (DR) relied on the order of the Assessing officer. 11. Ld Counsel for the assessee submitted that this issue is covered in assessee s own case for the assessment years , , and ld Counsel submitted that interest on Government Securities does not accrue on day to day basis but on fixed dates and the entry made in the books are not relevant for income tax purposes. 12. We have heard both the sides and perused the records of the case. We find that the issue is covered by the decision of the Tribunal in assessee s own case for the

6 assessment years , , and In A.Y , the Tribunal has allowed the assessee s appeal, inter alia, observing as under:- We have carefully perused the order of the Tribunal cited above. In that case also, the issue was identical, namely, whether in the case of Government securities, interest accrues on day to day basis or only on the coupon dates. The Tribunal held that interest accrues only on the coupon dates and not on day to day basis. In coming to this conclusion, the Tribunal placed reliance on the judgment of the Lahore High court in Haveli Shah Sardarilal v CIT,Punjab, 4 ITR 297, the Full Bench of the Patna High Court in Ranjit Prasad Singh v CIT, Bihar & Orissa (4 ITC 264) and the Karnataka High Court judgment in Addl CIT, Mysore v. The Vijay Bank Ltd., Mangalore (1976) Tax LR 524. It was also noticed by the Tribunal that the contention advanced on behalf of the revenue before Tribunal in that case was totally contradictory to the contention advanced by the revenue before the Karnataka High court in the case of Vijay Bank(supra) before the Tribunal. The department had placed reliance on the judgement of the Hon ble Bombay High court in the case of American Express International banking Corporation v CIT, 258 ITR 602 and Taparia Tools Ltd v. JCIT, 269 ITR 102. These two judgments have been considered by the Tribunal in paragraphs 14 to 17 of the order cited above and it was held that these judgements are not applicable to the facts of Union Bank s case. In paragraphs 20 and 21, the Tribunal has also considered the objection of the department that the assessee cannot credit the interest on government securities in the profit & loss account on day to day basis but contended that for purposes of income tax only the interest that accrued on the coupon dates can be assessed. The Tribunal noticed the judgement of the Supreme Court in the case of another bank, namely United Commercial Bank, 240 ITR 355. In this case, the Supreme Court has reversed the judgement of the Calcutta High Court, which held that the assessee cannot prepare the computation of its income for income tax purposes in a manner different from the method under which it keeps accounts. Applying this judgment of the Supreme Court, the Tribunal held that Union Bank of India cannot be prevented from urging in the return that the interest on govt. securities accrued only on the specified coupon dates notwithstanding that credit has been taken in the profit & loss account for the interest on day to day basis. Thus, the issue has been decided in favour of the view that the interest accrues only on the specified coupon dates and not on day to day basis. Since the facts of the present are identical, following the order of the Tribunal in the case of Union Bank of India (supra), we uphold the action taken by the CIT (Appeals) and dismiss the appeal. Consistent with the precedents, we dismiss this ground of the revenue.

7 13. Ground No.2 for the assessment year is similar to Ground No.3 for the assessment year , i.e. ld CIT (A) erred in deleting the disallowance on account of broken period interest paid by the assessee. 14. The Assessing Officer noticed that the assessee bank had paid an amount of 8,95,911/- as broken period interest on securities purchased during the year and lying in the closing stock. He noticed that the assessee bank followed the practice of debiting the P&L account with the interest paid and crediting the same with the interest received, treating the interest component as a revenue item. The AO was of the opinion that since the interest element was a part of lumpsum consideration, therefore, to the extent, the securities were lying in the stock, the interest paid on the same could not be disallowed as deduction, inter alia, observing that since they were current investments, the amount of interest paid on assets, which were purchased and sold during the year, was ignored. The AO had relied on the decision of the Hon ble Supreme Court in the case of Vijay bank, 187 ITR 541, wherein, it was held that the broken period interest paid is a part of capital cost of the asset. 15. Before ld CIT (A), the assessee submitted that the interest pertained to the period during which, the securities were held by the assessee did not accrue to the assessee but to the vendors. Accordingly, although the assessee received such interest from the issuer, it did not belong to the assessee and, hence, the same could not be subjected to tax in its hands. Ld CIT (A) pointed out that the facts in the case of Vijay Bank were different and the assessee s case was identical to the case of American Express International Banking Corporation. He, accordingly, allowed the assessee s appeal on this count. 16. Ld CIT D.R.in the written submissions, pointed out that it is only when securities which are not sold during the year that the broken period interest has not been allowed. Ld CIT D.R.pointed out that in the case of American Express International Banking Corporation, the decision of the Hon ble Supreme Court in the case of Vijay Bank (supra) was distinguished on account of the fact that in the case of American Express International Banking Corporation(supra), the securities were held as trading asset

8 whereas in the case of Vijay Bank (supra), the securities were held as investment/capital asset. Therefore, the basic dispute is regarding the question of fact as to whether the securities are held as trading asset or capital asset. In this regard, he referred to CBDT Circular No.665 of , wherein, it has been prescribed that the AO shall determine on the facts and circumstances of each case whether the securities constitute stock-in-trade or capital asset taking into account RBI guidelines in this regard from time to time. He referred to the annual report submitted alongwith return of income and pointed out that in the Schedule-8, government securities and other securities have been classified as investment and not as stock-in-trade. He clarified that the AO s observation in this regard for the A.Y are mis-placed as Schedule-8 to the balance sheet does not state that the securities are held as current investment and hence, they are stock-in-trade. Therefore, since the securities were held as investments/capital asset, the decision of the Hon ble Bombay High court in the case of American Express International Banking Corporation is not applicable. He further pointed out that during the year under consideration, Schedule-8 of the balance sheet of the assessee is in respect of investment and, there is no such item as current investment in the balance sheet, which can be treated as stock-in-trade of the assessee. He, therefore, in sum and substance, submitted that since the securities were capital asset, the broken period interest is to be capitalized with the cost of securities. However, he fairly admitted out that the AO had already allowed the broken period interest in respect of securities sold during the year, therefore, even if the securities are held as trading assets, the assessee would not be entitled to any further deduction and the disallowance of broken period interest with reference to securities not sold during the year was to be upheld. He submitted that in the present case, the decision in the case of Vijay bank (supra) is applicable. He further submitted that in case of any doubt in this regard, the matter may be restored back to the file of the AO to verify the same in view of RBI guidelines and Board s circular No.665. Alongwith written submissions, he has filed an Article giving details of RBI guidelines regarding securities by M.S.Prasad. 17. Ld counsel for the assessee submitted that in assessee s own case for the assessment year , the issue has been decided in favour of the assessee. He pointed out that the CIT (DR) in his submissions conceded that if the securities are held

9 as trading asset, then the broken period interest would be allowable. He clarified that the profit made by the bank on sale of the securities has been taxed as business profit and not as capital gain. In this regard, he referred to the AO s computation at the end of the assessment order. He further pointed out that this fact has been mentioned by the ITAT in its order in assessee s own case for the assessment year In reply to ld D.R. s submissions that the securities were shown in the balance sheet in Schedule -8 as investments, ld Counsel for the assessee pointed out that the said classification is for the limited purposes of compliance with the Banking Regulation Act. He pointed out that these very arguments raised by Ld CIT D.R.in A.Y have duly been considered by ITAT. In this regard, ld Counsel for the assessee placed reliance on the decision of the Hon ble Supreme Court in the case of United Commercial Bank,240 ITR 255 (SC), wherein, the Hon ble Supreme court observed that preparation of balance sheet in accordance with the statutory provisions would not disentitle the assessee in submitting the income tax return on real taxable income in accordance with the method of accounting adopted by the assessee consistently and regularly. He further pointed out that the entire interest received on the due date has been offered to tax and in fact taxed as income and, therefore, the broken period interest paid at the time of purchase had to be allowed as deduction. 19. We have considered the rival submissions and perused the record of the case. The only objection of ld CIT (DR) is that the securities had been classified as investments in Schedule -8 to the balance sheet. However, he has not controverted the findings recorded in A.Y regarding these securities being held as stocks-intrade. On the contrary, in all fairness he has accepted this fact in view of AO s findings. That being so, and in view of the decision of the Hon ble Supreme Court in the case of United Commercial Bank(supra), merely the classification of the securities as investment in balance sheet is of no consequence and the real income is to be determined as per the return filed by the assessee. We find that this issue is squarely covered by the decision of ITAT in assessee s own case for A.Y , wherein, in para 5, the Tribunal following the decision of the Hon ble Jurisdictional High Court in the case of American Express International Banking Corporation(supra), and the decision of the

10 ITAT in assessee s own case for A.Ys , and , we confirm the order of ld CIT (A). This ground is dismissed. 20. Ground No.4 raised in both the assessment years is against deletion of the addition on account of deferred guarantee commission. 21. Facts are that the AO required the assessee to submit the details of guarantee commission received during the year and whether the same had been accounted for as income or not. The assessee submitted that it was following mercantile system of accounting and, therefore, accounting the guarantee commission related to the year only. The AO was of the opinion that the transaction involving bank guarantee is only in the year the guarantee is given. The assessee got the right to receive the said commission in the said year. He observed that guarantee commission was not advance commission received and, therefore, there was no question of deferring the same to future year. He, accordingly, considered the entire income relating to guarantee commission in the year in which the guarantee was given. 22. Before ld CIT (A), it was contended that since the assessee was following mercantile system of accounting and had been offering to tax the guarantee commission during the currency of the period of guarantee, there was no justification to assess the same on receipt basis. Ld CIT (A) after considering the concept of accrual observed that since the obligation extended to the entire period for which guarantee was given, therefore, the guarantee commission also spreads over the entire period of guarantee. In this regard, he relied on the decision of the Hon ble Supreme Court in the case of Madras Industrial Investment Corporation Ltd v CIT (225 ITR 802), where while dealing with the issue of allowability of discount on debentures, the Hon ble Court held that the entire discount liability cannot be allowed as a deduction in one year and authorized spread over of the committed obligation to be discharged in later years. He also referred to the decision of the Hon ble Calcutta High Court in the case of CIT v. Bank of Tokyo Ltd. (71 Taxman 85), wherein, the Hon ble High Court, inter alia, observed as under:-.. It may or may not fructify into an actual right to receive for the subsequent period of the term of the guarantee as the sooner

11 determination of the guarantee is a contingency not ruled out by the agreement. It is only upon certain conditions being fulfilled, viz, the guarantee running the full course or period of the debt guaranteed, that the right to the entirety of the commission can be said to have accrued. 23. Ld CIT D.R.submitted that the bank provides bank guarantee to its customers to cover their liability and against this, charges its commission one time, which may or may not be refundable on revocation of guarantee before its maturity date. He pointed out that it is a question of fact which needs to be ascertained. He submitted that the decision in the case of American Express International Banking Corporation(supra),relied upon by ld CIT (A) is not applicable to the facts of the case because in the said decision, it was the expenditure which was claimed for spread over whereas in the case of the assessee, it is the income which has been received at the time of giving bank guarantee. Further in the case of debentures, the discount though accrued was payable in future spread over of debentures which is not the case of the assessee. Similarly, the decision in the case of Bank of Tokyo Ltd (supra), is not applicable because in the said case, the guarantee commission was refundable in case the bank guarantee was revoked before the time of full time period of guarantee. But in the present case, the AO has observed that the guarantee commission is not in the nature of advance commission. Thus, the decision in the case of Bank of Tokyo Ltd (supra) is not applicable. He submitted that the spread over of the guarantee commission can be allowed only if the commission was refundable on premature revocation of guarantee. He submitted that fact whether the commission was refundable or not has not been examined and, therefore, the matter may be restored to the file of the AO. 24. Ld counsel for the assessee relied on the order of ld CIT (A), the decision of the Hon ble Calcutta High Court in the case of Bank of Tokyo Ltd (supra) and also the decision of the Hon ble Supreme Court in the case of Madras Industrial Investment Corporation Ltd (supra). He submitted that in view of the decision of the Hon ble Supreme Court in the case of Madras Industrial Investment Corporation Ltd (supra), the guarantee commission is required to be spread over the period of guarantee on the principle of matching.

12 25. We have considered the rival submissions and perused the record of the case. The fundamental principle of taxing the income under the mercantile system of accounting is time of its accrual. It is not material whether the amount has been received at the time of accrual or not. The income is said to accrue when the assessee acquires the right to receive the same. Therefore, the basic question to be answered is as to at what stage the assessee acquired the absolute right to receive the income. The principle has been succinctly enunciated by the Hon ble Supreme Court in the case of E.D.Sasoon & Co. and others (supra), wherein, after considering the observations of Hon ble Justice Mukerji,J in the case of Rogers Pyatt Shellac & Co. v Secretary of State for India(1925) 1 ITC 363 at page 371 considered the term accrues, arises and is received and also the observations of Lord Justice Fry quoted by Hon ble Justice Mukerji, J in Colquhoun v Brooks and others decisions, observed as under:- It is clear therefore that income may accrue to an assessee without the actual receipt of the same. If the assessee acquires a right to receive the income, the income can be said to have accrued to him though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive the income. There must be a debt owed to him by somebody. In the light of above decision, the issue needs to be examined. Ld CIT (DR) has pointed out that the deciding factor would be whether the guarantee commission is refundable or not. If the guarantee commission was refundable then it cannot be said that absolute right to the commission had accrued in favour of the assessee at the time of execution of contract for furnishing guarantee by it but if the guarantee commission was not depended upon the period of guarantee and, thus, had accrued in favour of the assessee on the date of execution of contract for furnishing guaratnee then the same has to be taxed in the year in which the guarantee was furnished irrespective of the period to which guarantee remained alive. This is so because the guarantee commission cannot be apportioned with reference to the period over which the guarantee extended. Even in the case of Bank of Tokyo Ltd (supra) heavily relied upon by ld Counsel for the assessee, this principle has been accepted, which is evident from the observations noted in para 22 above. We, therefore, restore this matter back to the file of the AO to examine the issue in the light of above discussion and if he finds that as per the term, the commission was refundable on the revocation of guarantee, then the guarantee

13 commission is to be spread over the period for which the guarantee is given else it is to be taxed in the year the guarantee had actually been given irrespective of the period for which it spread. This ground is allowed for statistical purposes. 26. Ground No.5 similar to both the assessment years is that ld CIT (A) erred in deleting the addition being interest attributable to investment, dividends from which is exempt from tax. 27. The Assessing officer noticed that the assessee had earned dividend of Rs.1,13,63,468/- out of shares of various companies. He was of the opinion that since income from dividend was exempt from tax, therefore, proportionate disallowance was called for out of interest paid on borrowed fund. The assessee in its submissions pointed out that the investment was made out of its own funds and no expenditure had specifically been incurred wholly and exclusively for the purpose of earning such income. The AO did not accept the assessee s contention that since no specific borrowings were made for investment in shares, therefore, proportionate interest on borrowing should not be disallowed. He observed that the borrowed funds meant for the purposes of business had been diverted towards investment in shares and since the income was not taxable under the business head u/s.56, therefore, on account of its being exempt u/s.10(33), only net dividend is to be considered for exemption. He also pointed out that section 14A has been inserted in the Act, which provides that no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act. 28. Ld CIT(A) after considering the assessee s statement showing the position of non interest bearing funds and the amount of investment in shares reproduced at page 16 of his order, observed that in the year of investment, the assessee had sufficient funds available which were interest free funds, which has not been examined by the AO. He, therefore, allowed the assessee s appeal, inter alia, observing that no nexus had been established between the investment in shares and interest bearing funds. 29. Ld CIT D.R.submitted that the Special Bench of ITAT Mumbai in the case of Daga Capital Management, 117 ITD 169 has held that section 14(2) and 14A(3) as well as Rule 8D are retrospective in effect and, therefore, the disallowance is to be computed as

14 per Rule 8D. He, therefore, submitted that the matter may be restored back to the file of the AO. 30. Ld Counsel for the assessee reiterated the submissions made before the lower authorities and pointed out that the assessee has sufficient funds from which investments were made in shares. 31. We have considered the rival submissions and perused the record of the case. The applicability of section 14A cannot be disputed in view of the decision in the case of Daga Capital Management (supra), wherein, it has been held that section 14a(2) & 14A(3) including Rule 8D are retrospective in nature. At the time of hearing, it was brought to the notice of both the parties that the issue is pending before the Hon ble Bombay High Court in regard to 14A issue and, therefore, the appeal may be adjourned sine die till the disposal of the same by the Hon ble High Court. However, both the parties agreed that the matter may be restored back to the file of the AO in view of the decision in the case of Daga Capital Management (supra). We, therefore, restore this issue to the file of the AO. This ground is treated as allowed for statistical purposes. 32. Ground No.2 for the assessment year and Ground No.3 for the assessment year in regard to which reference has been made to the Special Bench reads as under: Whether on facts and circumstances of the case, can it be said that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the assessee on account of evaluation of the contract on the last date of the accounting period i.e. before the date of maturity of the forward contract. 33. Facts in brief are that the AO noticed that the assessee had booked a loss on revaluation of forward foreign exchange contracts, which were unmatured on the date of balance sheet, of an amount of Rs.12,42,648/-. He noted that the assessee enters into forward contracts with clients to buy or sell foreign exchange at an agreed price on a future date. This future price was estimated according to certain norms such as forward premium rates for certain currencies. He noted that when such contract was entered into, the bank normally booked loss or profit depending upon the difference between the prevailing exchange rate on that date and contract rate. On the maturity

15 of contract, the same profit or loss booked earlier was reversed and the actual profit or loss incurred based on the difference between the exchange rate on that date and the contract rate was booked. He pointed out that for transactions which mature during the year, the notional profit or loss gets replaced by actual profit or loss. There is no dispute in this regard and the same has been treated as revenues profits/loss. However, since in the forward contracts, the liability to purchase or sale of foreign exchange arises only on the date of maturity of the contract, therefore, the loss or gain depends upon the rate prevailing on that date and the contracted rate. Thus, he was of the opinion that the date of maturity of the contract is the relevant date for determining the profit or loss, accruing to an assessee, in pursuance to the forward foreign exchange contract. The assessee pointed out that as per RBI s guidelines, the banks were required to revalue unmatured contracts as per rates of exchange notified by Foreign Exchange Dealer s Association of India (FEDAI). Accordingly, on the balance sheet date, based on the exchange rate on that date, provision of profit/loss substitutes the figures booked at the time of contract. Thus, revalued loss/profit was debited to the profit and loss account. Further, this treatment was as per principles of accounting which required the current assets to be marked to the market rate. The AO did not agree with this modus operandi in regard to unmatured forward contracts. He further pointed out that in case foreign exchange is a current asset, the easier method of accounting would be to book the sale when it was done and the purchase when it was executed, which will determine gain or loss of the transaction. He further observed that the method followed by the assessee may be fair accounting principle to estimate the net worth but the principles of taxation required that actual profit or loss was brought to tax. He also observed that there are number of provisions in the I.T.Act which require the assessee to follow a different method than followed in its books of account. In this regard, the Assessing Officer referred to the decision in the case of CIT v. Motor Industries Company Limited (229 ITR 137), wherein, it has been held that the income tax law does not allow as expenses all the deductions a prudent trader would make in computing his profits. It is only the actual liability in present which is allowable and not liability in future which for the time being, is only contingent. It was also held that what a prudent trader sets apart to meet a liability, not actually present but only contingent, cannot bear the character of expenses till the liability becomes real. He also referred to the decision of

16 the Hon ble Supreme Court in the case of Indian Molasses case (37 ITR 66), wherein also, it was held that where the liability is contingent, the same is not allowable. The Hon ble Supreme Court observed as under:- The expenditure which is deductible for income tax purposes is one which is towards a liability actually existing at the time, but the putting aside of money which may become expenditure on the happening of an event is not expenditure. As regards the assessee s contention that bank was recording its income and expenditure on accrual basis, which was as per the provisions of Section 145 and the same could be disputed only if the profits or gains were not properly deducible from the same, the AO pointed out that the accounting method followed does not have much relation to the accrual basis of accounting. He observed that in forward contracts, liability arises only on the date contract matures. He pointed out that before the sale, it is only a contingent liability as the assessee could not foresee the rate of exchange which would prevail on the date of maturity of the contract. The AO referred to the decision of the Hon ble Madras High Court in the case of Indian Overseas Bank(183 ITR 200), wherein, similar issue was examined and it was held that before settlement of contracts in foreign currency, no actual profit could accrue. It was held that the amounts in question represented notional profits only. Drawing analogy from this decision, the AO disallowed the loss of Rs.12,42,648/- treating the same as notional loss. The AO, however, allowed the amount which was disallowed on this count in earlier years. 34. Before ld CIT (A), it was contended that the assessee was required to revalue its outstanding forward foreign exchange contracts as per the rates of exchange notified by the Foreign Exchange Dealer s Association of India on March 31, every year as per RBI guidelines. The gain or loss on revaluation of the outstanding contracts was booked in the profit and loss account as per the mandatory requirements of RBI guidelines. The assessee relied on the decision of the Hon ble Supreme Court in the case of United Commercial Bank v CIT,240 ITR 355 and also on following decisions:- 1. Bank of Tokyo v IAC, 13 ITD State Bank of Mysore v CIT, 114 ITR 704 (Kerala) 3. CIT v. Canara Bank, 63 ITR 328 (sc) 4. ONGC v DCIT, 83 ITD 151 (Delhi)

17 Ld CIT (A) allowed the assessee s appeal, inter alia, observing that the assessee was offering profits resulting from such revaluation as and when they so arise and the AO had never objected to the profits which was shown on revaluation of outstanding foreign exchange forward contracts. In this regard, ld CIT (A) relied on the decision of ITAT Mumbai in the case of Deutsche Bank A.G v DCIT, 86 ITD 431, wherein, it has been held that income/loss on revaluation of forward foreign exchange contracts is not notional in nature and, therefore, needs to be considered in preparing computation of total income of the assessee. He also pointed out that in this case the decision of the Hon ble Madras High Court in the case of Indian Overseas Bank (supra) has been distinguished. 35. Ld CIT D.R. Shri Ajit Kumar Sinha submitted that the assessee is carrying on banking business in India and it is not the assessee s business to deal in forward contracts. It entered into forward contracts with its clients to buy or sell foreign currency at an agreed price on a future date in order to protect the interest of the bank. He submitted that it is a tool to safeguard the assessee s interest. Ld CIT D.R. submitted that these contracts are entered into in order to avoid wide fluctuation in foreign currency. He submitted that there is no dispute in regard to contracts which matured during the year in which they were entered into and the loss/profit was claimed as deduction/income, had been allowed/taxed, accordingly. The dispute is only in regard to those forward contracts, date of maturity of which fall after the end of the accounting year. The assessee revalued its profit/loss on notional basis as per rate of exchange prevailing on the balance sheet date and claimed the same. Ld CIT D.R. submitted that the reference to the Special Bench has been made because the decision of ITAT in the case of Deutsche Bank A.G., 86 ITD 431(supra) and that of the decision of the Hon ble Bombay High Court in the case of Bank of India, 218 ITR 371 relied upon by the assessee proceeded on the footing that the securities were stock-in-trade but as far as the forward contract is concerned, the same is not stock-in-trade and, therefore, those decisions are not applicable. He pointed out that there is no material to prove that forward contract to buy or sell foreign currency itself constitutes the stock-in-trade as the assessee does not trade in such forward contract. He, therefore, submitted that the decision which proceeded on the basis of foreign currency being stock-in-trade cannot be relied upon in the present set of facts. He further pointed out that these

18 transactions are not recorded in the books of account and hence, there cannot be any liability from income tax point of view. Thus, there cannot be any question of computing any notional loss for the purposes of income tax. He submitted that the foreign exchange contract cannot be considered on the same footing on which foreign exchange currency being stock-in-trade is considered. In this regard, Ld CIT D.R. referred to the decision of the Hon ble Supreme Court in the case of CIT v. Woodward Governor of India, 312 ITR 254 (SC) and pointed out that in para 18, while considering the applicability of AS-11, the Hon ble Supreme Court noted that exchange difference arising on foreign currency transaction have to be recognized as income or as expenses in the period for which they arise, except as stated in paras 10 & 11, which deals with exchange difference on repayment of liabilities incurred for the purpose of acquiring fixed asset. It was, inter alia, observed that AS-11 stipulates effect of changes in exchange rate vis-à-vis monetary items denominated in a foreign currency to be taken into account for giving accounting treatment on the balance sheet date. Ld CIT D.R. pointed out that in the present case, since no transaction has been entered into in the books of account, there was no monetary item requiring adjustment of exchange rate difference. Ld CIT D.R.thus, submitted that the manner of holding foreign currency is relevant and if the same is held as stock-in-trade then in view of the decision of the Hon ble Supreme Court in the case of Woodward Governor of India(supra), the exchange rate difference on the balance sheet date has to be considered for tax purposes. Ld CIT D.R.referred to the decision of the Hon ble Bombay High Court in the case of CIT v. Kamani Metals and Alloys Ltd, 208 ITR 1017(Bom), wherein, the facts were that the assessee had entered into a contract with MMTC on August 27, 1974 for purchase of 49,981 kgs copper cathodes at the rate of Rs.33,825/- per M.T. The assessee had opened an irrevocable letter of credit on 28 th September, However, till the end of the relevant accounting year, no material was received by the assessee. The MMTC announced price of copper cathodes at Rs.25,461/- per M.T. for the quarter January to March, The assessee received the material on In the backdrop of these facts, the assessee made a provision amounting to Rs.4,18,021/- for the anticipated loss in the purchase account representing the difference between the contract price and the market price on the date of receipt of the material as the market price of the copper cathodes was less than the contract price. The assessee s claim was

19 allowed by the Tribunal. However, when the matter traveled before the Hon ble High Court, it was held that under the contract in question, no raw material was in fact purchased by the assessee during the relevant accounting year. The material was received in the next accounting period on The Hon ble High Court held that since there was no closing stock of the material in the hands of the assessee and only contract with MMTC was there, therefore, the material contracted to be purchased could not be regarded as assessee s stock-in-trade and hence, could not be valued in the accounts as such. Accordingly, the anticipated loss was disallowed by the Hon ble High Court. Ld CIT D.R.relying on this decision submitted that this covers the issue before us and on same parity of reasoning; the forward foreign exchange contract remaining unsettled at the closing balance sheet date could not be treated as stock-in-trade. 36. Ld CIT D.R. further submitted that the decision in the case of Deutsche Bank A.G. (supra) relied upon by ld CIT (A) is not applicable as the same proceeds on a wrong premise that unsettled forward foreign exchange contracts as on balance sheet date constitute the stock-in-trade. Thus, the very premise is wrong on which the decision was delivered. He submitted that the circular No.664 dated referred to in the case of Deutsche Bank (supra) talks only about securities and not forward contracts. Therefore, the said circular is not applicable in the present facts. Ld CIT D.R.further referred to the decision of the Hon ble Supreme Court in the case of Indian Molasses Co. Ltd v CIT, 37 ITR 66 (SC), wherein, the Hon ble Supreme Court, inter alia, observed that income tax law does not allow as expenses all the deductions a prudent trader would make in computing his profits. It was further held that in finding out what profits there be, the normal accountancy practice may be to allow as expense any sum in respect of liabilities which have accrued over the accounting period and to deduct such sums from profits. He, therefore, submitted that unless the liability actually accrued on maturity of the contracts, there could not be any allowable expense on account of variation in the rate of exchange as compared to contracted rate at the end of the financial year. 37. As regards the assessee s submissions that the valuation was done as per the guidelines of FEDAI, Ld CIT D.R.submitted that the income or expense is to be

20 determined as per the requirements of Income tax Act and as per the guidelines prescribed for preparation of accounts. 38. Ld CIT D.R.further referred to the decision of the ITAT Calcutta Bench Third Member in the case of Eveready Industries India Ltd v. DCIT, 78 ITD 175 (Cal), wherein, it was held that exchange fluctuation loss of un-matured forward covers (i.e. forward contract) could not be allowed on accrual basis. However, since the assessee claimed that such contract got settled during the year and only remittance was made, the issue was set aside to the AO to ascertain the fact and reconsider the claim of the assessee in accordance with law. Ld CIT D.R.referred to section 145 of the I.T.Act and pointed out that as per sub-section (3), if the AO is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting or accounting standard have not been regularly followed, then the AO can make assessment u/s.144. He submitted that the main object of section 145 is to compute the correct profits and if the correct profits cannot be deduced from the accounts then he has to compute the profits on his own. Ld CIT D.R.further referred to the decision of the Hon ble Calcutta High Court in the case of Bestobell India Ltd, 117 ITR 789(Cal), wherein, the facts were that the loan of 37,500, being about Rs.5 lakhs was taken by the assessee from its subsidiary company to be repaid at the expiry of one year or earlier. However, the loan could not be repaid within the stipulated period and on account of devaluation of Rupee, there was increase in loan liability on account of sterling loan. It was held that increase in liability was inextricably connected with assessee s indebtedness and was capital in nature. Thus, in sum and sub stance, the arguments of Ld CIT D.R.are as under:- i) Unsettled forward foreign exchange contracts does not constitute stock-intrade and, therefore, there is no question of its valuation. ii) No transaction has been recorded in the books of account in regard to unsettled forward foreign exchange contracts and, therefore, there is no question of its valuation being done at the end of the accounting year.

21 iii) iv) The anticipated loss is primarily in the nature of notional liability and, therefore, does not accrue/arise at the end of the previous year and hence, not allowable. The liability accrues or arise only on the date of maturity of the contract and prior to that purely on the basis of estimated liability as per FEDAI guidelines it cannot be allowed under I.T.Act. v) Various decisions relied upon by ld CIT (A) relate to stock-in-trade and not to unsettled forward foreign exchange contract. vi) The issue is squarely covered by the following decisions:- a) Indian Overseas Bank Ltd., 246 ITR 206(Mad) b) Indian Overseas Bank Ltd., 151 ITR 446 (Mad) c) Kamani Metals & Alloys Ltd., 208 ITR 1017 (Bom) d) Bank of India, 218 ITR 371 (Bom) e) Eveready Industries (I) Ltd., 78 ITD175 (Cal) f) Indian Molasses Co. Ltd., 37 ITR 66 (SC) 39. Shri F.V.Irani, ld Counsel for the assessee submitted that there is no dispute regarding allowability of assessee s claim and the only dispute is regarding timing i.e. year of allowability. The whole controversy is whether on the balance sheet date the estimated loss as per the FEDAI notification as per RBI guidelines is accrued loss or notional loss. Ld Counsel for the assessee referred to page 8 para 5.3 of ld CIT (A) s order for A.Y and pointed out that he has taken note of the fact that as per the RBI guidelines, the assessee was required to revalue its outstanding foreign exchange forward contract as per the rates notified by the FEDAI on March 31 st every year. Ld Counsel submitted that the assessee had to re-assess the anticipated loss at the end of the year in accordance with the method of accounting consistently followed by it. Therefore, it was allowable. Ld counsel submitted that now the issue stands settled by